Australia: Distressed property: Preserving value and mitigating risks

Security review and asset protection / sale of assets

Step 1: Security review and asset protection

  1. Identify assets critical to maximising realisation.
  2. Review securities to ensure control of all relevant assets.
  3. Identify risk factors.

Risk factors include:

  • Third party interest
  • Legislation
  • Environmental issues
  • Restriction on buyers - Seniors Living SEPP
  • Security cross collateralisation
  • Water rights

Step 2: Sale of assets – maximising value

  1. Methods of sale: private treaty, auction, formal tender, EOI or informal tender.
  2. Pre GFC: When the economy is booming and assets are easier to sell and purchasers have no difficulty obtaining finance auctions are prevalent as it creates momentum and an urgency which can contract the sale process. the faster assets are disposed of the quicker money is returned and holding risk is reduced.
    Post GFC: Following the GFC life is different. Finance is harder to get, the number of buyers is reduced and more work goes into asset disposal. tenders and eoi are more common as they allow the smaller group of buyers to strike a deal which is more palatable to them.
  1. Factors in maximising value:
    • Apply for development consent or complete a development
    • Leasing up – commercial property
    • Remediate contamination
    • Expending money to enhance a quality
    • Trade a business to build up value

Dealing with risks that may be encountered on a distressed development project

Distressed projects will haemorrhage money. You need to:

  • Know what you are doing
  • Have systems and checklists in place beforehand to deal with the risks
  • Act quickly and decisively

Otherwise, if the risks materialise you will lose value in the project or worse.

What risks are we talking about?

  • Time: the risk that delays on the project will erode the value in the property and to prevent such delays.
  • Cost: the risk of incurring additional costs or suffering cost overruns as a result of having to deal with a distressed development and to cauterise those costs.
  • Quality: the risk that work will not be performed to the required contractual standard, resulting in a decrease in the value of the property and ensuring that that does not happen.

Three step process to preserve value and mitigate the risks on a distressed development site

  1. Do a stocktake of the project
  2. Identify and assess the risks
  3. Prepare a strategy to mitigate the risks

These situations do not lend themselves to half measures or errors. Action must be decisive and strategies must be in place to stabilise the situation.

Step 1: Stocktake Checklist (key areas of housekeeping)

  • Financing documents
  • Authorisation to redevelop
  • Construction contract
  • Builders side deed/Financiers tripartite deed
  • Latest payment claims, certificates and any QS reports
  • Security (bank guarantees or insurance bonds)
  • PPSA (Personal Properties Security Act)
  • As-built drawings, including all drawings from consultants such as mechanical, electrical, fire, hydraulic, structural and architectural drawings
  • Third party warranties/certificates from such people as waterproof membranes, etc
  • Inspection records required for ultimate certification
  • Construction certificates, compliance certificates, fire safety (for occupation certificates)

Step 2: Identify and assess the risks

The assessment of the risk (time, cost, quality), including the likelihood of it arising and its severity, will inform you as to the mitigation strategy to be adopted to deal with the risk and to assess the impact (if any) on the value of the property.

Time risk assessment:

  • Date for practical Completion and has this date been delayed?
  • Has there been notification of any other expected future delays?
  • Assess the causes of the delay to identify the allocation of risk
  • Assessment of likely costs that will flow from delays:
    • Liquidated damages (or general damages)
    • Delay damages or prolongation costs

The cost consequences of delay and the impact on the value of the project will formulate your strategy as to whether:

  • You elect to retain or terminate the builder
  • Take urgent steps to remove parts of the work from the builder and give to another contractor
  • To take steps to accelerate the work to overcome the delays
  • Financial perspective, accept liquidated damages as fair compensation for the loss in value of the property

There might be so much uncertainty that the assessment demands the involvement of an expert programmer to assess the time impacts on the project

Cost risk assessment:

  • How much has been paid out on the project?
  • What is the estimated cost to complete? What is the cost overrun on the project, if any?
  • What are the categories of additional costs such as variations, delays, latent conditions? An early warning indicator of potential dispute in relation to time, cost or quality issues
  • Whether there are outstanding claims for payment? Whether those claims have been issued under the security of Payment legislation?
  • Having assessed the risk of additional costs and overruns on the project will formulate your strategy as to whether:
    • you elect to retain or terminate the builder
    • sell the project as is
  • How to deal with outstanding claims to subcontractors and suppliers for which the owner may be liable under:
    • Security of payment legislation
    • Workers Compensation Act
  • To fight vs avoid dispute by approaching the builder to negotiate in respect of outstanding claims for payment
  • To have recourse to security (performance guarantees) for default
  • To retain another QS to assess the project cost, budget and value of work

Quality risk assessment:

  • Terminating and taking over may save time, but how will changing contractors change this? Can anyone else do the job?
  • How will the marketability of the project be affected?

The assessment of cost risks on the project will cover the following territory:

  • Cost risk assessment:
    • QS and valuation update
    • New contractor costs?

Step 3: Mitigate the risks / conclusion

Having worked through steps 1 and 2 and assess the risks on the project, the 3rd step in preserving value and mitigating risks is to develop the risk mitigation strategy.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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